Facts don't support stock market bubble talk

May 20, 2014 

For the last few months it has been hard to visit any financial publication or website and not see some coverage about how stocks are in a bubble, with the collapse imminent. At first glance these stories seem to have some merit.

The U.S. stock market has risen more than 150 percent in the last five years, starting in the depths of the financial crisis in the spring of 2009. 2011 was basically a non-event, but stocks still rose just a bit despite a large correction in the summer and early fall of that year. Of course, 2013 got everyone's attention with a gain of over 30 percent for the S&P 500 Index, the best year since 1997.

Do stocks have to be in a bubble because they have risen for five years? The answer to that is a resounding "no." Bear markets (declines over 20 percent) have tended to occur every 5 to 6 years through history, but they aren't on a schedule.

It would be foolish to turn a blind eye to the fact that, eventually, we will have a significant correction, and normal 10 percent corrections can strike at any time. The longer prices rise, the larger the correction may turn out to be as the excesses of optimism are corrected. What justifies a "bubble" or excess in stock prices?

I think some clues may be found in the valuations of one asset class, like stocks compared to other assets that investors can chose to own as an alternative. The last true bubble in stock prices was in the year 2000, when technology and dot.com com

panies were bid up to excessive valuations.

(Note: the significant stock market decline of 2008 -- 2009 was not the result of over-valuation, or bubble in stock prices. In that case the integrity of the financial system was called into questions from excessive leverage and risk taken by banking institutions, primarily related to the real estate market.)

In the 2000 bubble, the earnings yield on the S&P 500 Index was only 3.8 percent, the price to earnings ratio was 26. At the same time investors could buy a 10 year U.S. Treasury Bond and earn a guaranteed 6.2 percent. Of course, the big money flowed out of overvalued stocks into bonds, resulting in the deflation of the tech bubble.

Fast forward to today. The earnings yield on the S&P is 6.3 percent and the PE ratio is 16. This compares favorably to the 2.7 percent yield available on a 10 year treasury bond. In other words, there doesn't seem to be a lot of incentive for investors to sell socks in favor of buying low yielding T-bonds.

The future is hard to predict and I suggest being careful with your investment capital, but don't be too quick to subscribe to the bubble theory until the facts bear it out.

Tom Breiter, president of Breiter Capital Management, Inc., a registered investment adviser, can be reached at (941) 778-1900 or by e-mail at tom@breitercapital.com

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